THE STEINHOFF DISASTER
“Steinhoff International (JSE:SNH), of Stellenbosch, South Africa, was proud to say that it was perfectly normal, thank you very much. It was the last company you’d expect to be involved in anything strange or mysterious because it just didn’t hold with such nonsense . . .” – Just as Harry Potter was a fictional story, so too was Steinhoff’s financial reporting.
Steinhoff used to be a story of success. It built an international and world renown retail franchise, developing its reputation over a period of 5 decades. It took all but a few days to completely wipe out the reputation and millions of rand in value. Just like the well-known Enron scandal of 2001 or the Lehman Brothers scandal of 2008, Steinhoff gave South Africa its own scandal.
The adage of it takes a lifetime to build a reputation but only a second to destroy it has never been truer.
In March 2016 the share price hit a high of R95.04. The next year saw a gradual tapering off of the value to the mid R 60’s where the share proceeded to hover for another year. The price of the share was R 55.81 in December 2018, at which time pundits were calling the share undervalued and offering an enticing “buying” opportunity.
24 hours later the share was R 6.00 and in the proceeding weeks down to R 1.21.
MY PERSONAL DISASTER
Having been invested in the company in my personal capacity, as well as at in my investing company, I felt the sting of this large loss first hand. It is a frustrating experience to be the victim of deceit and corporate dishonesty, as there is little to no chance you can pick it up. You rely on financial institutions, governance structures, regulations and auditors to verify the information. Yet they all failed. Although I would like to lay the blame at the feet of many different parties, it does not change the fact that I now had a share with a 96% loss. This is not an ideal inclusion to be sitting on my short investing track record.
“The past cannot be changed. The future is yet in your power.” – Mary Pickford
As Mary Pickford said “The past cannot be changed. The future is yet in your power.”. With this in mind I started perusing what I should do with my now significantly devalued share.
As the cliched value investor I pretend to be, I attempted to convince myself it is a long term hold. “Hold on to it for the long term and it will recover its value, assuming the underlying company is still worth something.” – is what I told myself.
This thinking led me down the rabbit hole of “how much would my share need to appreciate (lift in value) in order for me to recover my money?”.
A relatively simple calculation showed that it would take a gain in share price of 2,757% just to break-even. How many shares do you know that have gained that amount of % in recent history?
Me neither – although I am sure there were some crypto fanatics out there with a point to make in 2017.
THE LOSS RECOVERY THEORY
The extraordinary gain that is required to offset a loss is a fascinating topic. It is often not correctly understood by investors. The misconception is that a 10% loss can be recovered by the same 10% gain. In fact it takes a lot more growth to recover a loss than would be expected.
It is a misconception that a 10% loss can be recovered by a 10% gain
To indicate this phenomenon, we created the graph below.
This graph indicates what I decided to coin the Loss Recovery Theory. Essentially it shows you the ranges of recovery needed to offset a loss after it has occurred. For example, a 10% loss requires an 11% gain to break even, an 80% loss requires a 400% gain and a 90% loss requires a subsequent 900% gain.
As you can see the amount increases exponentially. I didn’t include the 99% loss because it distorted the graph, but this would require a monumental 9900% increase to get your money back.
Why is this the case? It has to do with base level. If you have R100 and lose 10% you now have R90 correct? If you make a 10% gain, you would go from R90 to R99. As you can see you lost 10% and gained 10% but still lost R1.
I decided I could not wait to recover my money from Steinhoff for several reasons. Not least amongst them being that I did not expect a 2,757% gain. I realised the loss and used it to offset my gains for tax purposes. Although this disaster led me to think about the Loss Recovery Theory and how it relates to South Africa.
RELATING IT TO QUALITATIVE THINGS
Coming back to the beginning of 2018 in South Africa, after the NEC election, the first half of the year was gripped by “Rhamaphoria”. The winds of change were expected to promote real growth and lift an economy that has struggled for many years. Significant issues formed in South Africa under the Zuma-regime. These included the historic maladministration and lack of investment in SoE’s and the over-indebted and embattled consumers fighting questionable fiscal and monetary policies. As well as demands and different opinions over land expropriation, a new mining charter and previously unchecked corruption at all levels of the public sector desperately needing to be addressed.
The “Rhamaphoria” could not translate into real growth in half a year.
While real growth did not appear, this is understandable given Loss Recovery Theory.
Just like the tumultuous decline of my Steinhoff share, South Africa had fallen into a pit of corruption, selfishness and poor strategic decision making. Taking the theory and applying it to South Africa, like my path to recovering my loss, it is going to to take substantially more time and effort to rectify the past mistakes then it did to make them.
It is not going to be a quick or a painless process for the country to pull itself back together. But we will need to do so in order to promote real growth. However, unlike my Steinhoff share recovery prospects , I think it is certainly achievable for South Africa. We can climb back up the figurative ladder of success. Most importantly do not expect it to happen overnight or even this year. Remember recovering losses is a longer road than you would expect . . .